Furthermore, the Russia-Ukraine war is causing ongoing destruction of refinery capacity and also affecting food exports through the Black Sea. These geopolitical events add up to a large negative and persistent global supply shock creating additional inflationary pressures. In this context, more central banks are raising rates. These include the European Central Bank, the Bank of Japan, as well as the United States Federal Reserve, which hiked rates last week for the first time in three years. We have also seen longer-term interest rates moving higher recently with various benchmarks reaching multi-decade highs. The main drivers of this include large fiscal deficits in major economies as well as inflation risks and heavy borrowing to fund infrastructure for artificial intelligence. Despite these stresses, world growth is holding up. Nonetheless, shocks are multiplying and vulnerabilities are increasing. The global economy is not in a healthy space.
Turning to South Africa, in our last meeting, we warned of downside risks to growth. The data has now shown that the economy contracted in the second quarter by 0.2%. We still expect a rebound during the second half of the year with annual growth projected at 1.2%. The global shocks are clearly hitting our economy. We continue to project growth of around 2% over the medium term. This is based on global conditions stabilizing and domestic reforms delivering a better business environment. Our assessment is that growth risks are skewed to the downside.
Moving to inflation, we have raised our near-term focus. This is mainly because of higher fuel prices. For example, petrol is rising again after moderating between June and August with an average under-recovery of two rand 83 cents per liter. Currently, headline inflation will likely be above 5% later this year and early next year before slowing as the fuel shock recedes. We currently expect inflation to be back around 3% towards the end of 2027. In contrast to fuel, inflation developments in food and core goods have been more favorable. Import prices remain contained with help from the rand, which has been notably resilient throughout the year. Meanwhile, food inflation is at its lowest since 2010. This reflects strong harvests as well as leveling off in meat prices following the outbreak of foot-and-mouth disease. We may start to see drought pressures from El Niño soon, but for now, agricultural conditions are broadly favorable.
By contrast, services inflation is elevated. Some of this reflects temporary pressures, for instance, in transport. But we also see price hikes well above the 3% inflation target in many other categories. These increases often do not reflect a true picture of where inflation has been and where it is going. Accordingly, an important part of lowering services inflation is getting inflation expectations lower. Based on the latest survey from the Bureau for Economic Research, expectations have eased slightly after rising in the previous quarter. That said, they remain high with long-run expectations around 4% rather than our 3% target. We are also cognizant that this survey was conducted before the recent fuel price increases. In this context, we note that market-based measures of expectations have picked up lately after moderating earlier in the quarter. We see upside risks to inflation.
Against this backdrop, the committee decided to raise the policy rate by 25 basis points to 7.25% and we take responsibility for delivering that outcome. The forecast from our quarterly projection model has the policy rate broadly stable through the remainder of this year. The model shows cuts later in the forecast as inflation falls to 3% and the QPM moves to a more neutral policy stance. As before, this rate path remains a broad policy guide. Our decisions will continue to be taken on a meeting-by-meeting basis with careful attention to the outlook, data outcomes, and the balance of risks to the forecast.
To support the risk assessment for this meeting, we considered a scenario with higher global interest rates. Our baseline forecast has the major central banks raising rates by about half a percentage point between this year and next. Our scenario doubled that taking the increase to a full percentage point. This causes rand depreciation which lifts inflation. The model responds with a tighter policy stance with rates about one hike above the baseline path and slower cuts. Subsequently, we also looked at a scenario with higher inflation expectations and wage increases. This also showed a tighter resistance with between one and two hikes above the baseline peak and rates staying higher for longer.
Overall, this is proving to be a difficult year for the global economy and for South Africa. Geopolitical conflicts have caused severe negative supply shocks which weaken output and raise inflation. South Africa's growth recovery has slowed while inflation has increased well above our target. Our approach is to look through the initial effects of price shocks while ensuring that they do not entrench higher inflation. Unfortunately, large and sustained shocks like those we are experiencing now are more likely to trigger second-round effects where individual price changes evolve into widespread increases. To prevent this, we are adopting a more restrictive monetary policy with rates above longer-term levels. Because of the adverse global environment, domestic reforms are our best growth option. This covers structural interventions such as improving productivity in the transport and energy sectors. It also includes the macroeconomic goals of sustainable debt and permanently lower inflation. Indeed, in a world of excessive debt and elevated inflation, our macro fundamentals are becoming a differentiating factor for South Africa, lowering our country risk premium and helping to protect us from the global bond selloff. As the Monetary Policy Committee, our primary role is to protect the value of the currency by getting inflation back to 3% over time. We will act as needed to achieve this goal.
This concludes the statement and at this stage we would like to pause and take questions from members of the media. As usual, please identify yourself and the media house that you represent and we will deal with your questions.
Good afternoon, Governor and the rest of the MPC. Copanogi from Reuters. I'm wondering around the second round effects. Up until now it doesn't appear to be that second round effects have taken or started to show in the economy. And I was wondering if this is out of the ordinary that first round effects wouldn't have kicked in by now given how long the shock has been and how high elevated oil prices have been. And if it's not out of the ordinary, are there times before that this has happened? And when do you expect to see these second round effects? As you say, food has been low. Administered prices have settled somewhat. The only concern, as you say, is services prices inflation, but and you're doing something about it preemptively now by putting in this 25 basis point hike. But for the more broad costs or price rises, when do you expect to see those given that up until now they haven't happened? And then secondly, at the last meeting it appeared that the MPC took domestic growth into consideration when you paused but the South African economy as you see now remains weak and even as inflation risks are on the upside. In the previous meeting, you decided to protect growth, which didn't happen, but now when you were talking about the rate path for this specific meeting and this call, what were some of the take into consideration that caused you to hike? Thanks.
Thank you very much. Antonio, how much more restrictive is policy now? 25 basis points tighter right because that's what we had adjusted and I guess when we say it's more restrictive is because the current stance was not necessarily accommodative either. It was marginally restrictive and what we have done was to increase the extent of restrictiveness by an additional 25 basis points. Unanimity, it's a very scarce commodity in this committee and when you get it you must embrace it. Yes, there was a discussion about 50 basis points. There was also a discussion about holding and that is the nature of the committee. You have got to weigh all of these policy options and decide what is the most appropriate policy option that you must exercise at this point given the state of the economy and the risks that are attended. Yes, we had the discussion but eventually the general agreement was that we must go with 25 basis points.
Now, lady, inflation remaining elevated and you talked about administered prices. It's not like administered prices have risen faster than what we had expected over the previous meetings during the course of this year except for one administered price which is the fuel and that fuel price is driven by the oil shock. So that is where the thing is coming from. So you asked what if the pressure was to come from both internal and external. Well, at the moment it is mainly externalities from the oil shock. Of course, if the domestic prices also begins to rise, then that complicates your inflation picture. But then that begins to tell you that second round effects are kicking in as a result of the shock that you had experienced.
And then Copano, the second round effects, is this out of the ordinary and the timing of food. The interesting thing here is that food this time is playing a first round effect because it had been disinflating. Food inflation is actually very very low and so the other first round effect is the shock. So now let's try and get into the second round effects. Because you act to deal with the second round effects. But if you wait until they are here in the room, you are too late. It's outside of your policy horizon. There is almost nothing that you could do about it. But you mentioned we talked about services inflation rising and we have repeatedly meeting after meeting talked about services inflation. We did some diffusion and we tried to drill a little bit deeper so that we can get an understanding and so we took Statistics South Africa's 8-digit coding which covers 73 items and we found that of those items some 76% were rising at rates that are higher than the target. And then we said let's lift the bar. How many are rising above 4% which is the upper level of our tolerance band and we found that just around 65% of the items if you use 4% as a threshold they are rising above 4%. And we said okay let's test this a little bit further because we expect that inflation will rise to about 5% during the fourth quarter and when we tested that we found that 35% of the items would be rising at faster than 5%. That was beginning to tell us that the prices are spreading and this is for the services in there and we had to be worried about that. And then you said you acted preemptively. No, that's not what we did. We acted on the best evidence that we have at the moment and the risks attendant to the outlook.
And then you said that in the previous meeting we seemed to be acting to protect growth or to take growth into account. Of course, we always take growth into account because our mandate says that we must do what we do in the interest of balanced and sustainable growth. But importantly, when there is a shock like the one that we had experienced, it has an adverse impact on growth and an adverse impact on inflation. It leads to rising inflation and slower growth. Now the slowing of growth itself could actually become disinflationary because it pushes the economy below potential. And you will see that in the sheets that we gave you that the output gap has become more negative than it was at the previous meeting. So we take cognizance of the growth and the growth dynamic to the extent that it has got an impact on the inflation outcomes because remember our responsibility is price stability because it is with price stability that you have balanced and sustainable growth. That is where we come in as the central bank.
